In the past, corporate bank lending was typically arranged based on a personal relationship between a bank (the lender) and its borrower. However, since the mid-1990s, the growing sophistication of financial engineering and the rise of private equity, leveraged buy-outs and general merger & acquisition activity led to increased use of debt in corporate transactions and in turn larger loans. With larger loans came the need to syndicate these large loans so that no one lender was assuming all the risk should a borrower default on the loan. Also contributing to the rapid growth in syndicated lending was the introduction of non-bank lenders, including hedge funds, mutual funds and CLOs—specialized investment vehicles whose sole purpose is to invest in syndicated loans. As a result, loan syndicates can be a diverse and fragmented group of investors, with the original underwriter carrying little if any risk exposure to the borrower.
Many large corporations have a need to borrow large sums of money for working capital, to purchase capital equipment, to acquire a competitor or to finance management buyouts (MBO). One way to raise this capital is through loans from a bank. Some loans are too large for one single bank to handle—especially when the company is seeking to assume significant indebtedness in which case the bank will ask other lenders to step in as co-lenders. Over the past 20 years, this market for co-lender loans—or leveraged loans—has grown dramatically. Today, approximately 300 financial institutions are active participants domestically in the leveraged bank loan market. The majority of these institutions are professional money management firms, not banks. The structure of these professional money management firms, also known as institutional lenders, is different from banks. For example, they have different regulatory requirements and often manage more than one asset class. Examples of other asset classes include stocks, bonds, insurance, real estate, and commodities. It is the bank loans asset class which is our initial focus, but because they handle many other asset classes as well, the compliance regime is complex. Furthermore, because these institutional lenders act as money managers for their clients, they oftentimes have complicated legal structures; some institutional lenders manage money via more than 50 different legal entities, all or only a subset of which may be co-lenders to the same bank loan. The growth and complexity of these non-bank institutional lenders makes the administration of modifications to credit agreements cumbersome.
Syndicated bank loans typically have maturity dates of 5-7 years and are governed by credit agreements containing restrictive covenants which the borrower must adhere to for the protection of the lenders. A borrower may require a modification of the terms of the credit agreement, otherwise known as an amendment, because its circumstances have changed, either as a result of changes in the economic climate or the competitiveness of the industry in which it competes, or simply because of growth. Historical data shows that 25-30% of all credit agreements are modified prior to maturity for these reasons. Most amendments to a credit agreement can be effectuated with the consent of Required Lenders (typically a majority of the syndicate of lenders). When credit agreements are changed, the risk parameters lenders originally bargained for are changed, often to become less restrictive for the borrower, which in turn increases the risk profile for lenders in the syndicate. Although credit agreement modifications impact (and typically increase) the credit risk profiles of all lenders in the syndicate, only those lenders who consent to the changes proposed by borrowers are paid a consent fee in exchange for agreeing to the new credit agreement terms, which if approved are imposed on all lenders in the syndicate.
Because syndicated loans are held by a wide group of lenders, many lenders view their individual vote as having little significance in determining whether an amendment will be accepted. In addition, they recognize that if an amendment does pass, those lenders who choose not to consent will not receive the consent fee but will still assume the same risks as the consenting lenders. As a consequence a lender may vote to accept an amendment it might otherwise view as presenting an unacceptable risk-reward profile in order to secure the consent fee. This is most pronounced in widely held loans, where lenders conventionally lack the transparency to know whether a request has the support of other lenders Without greater transparency and dissemination of vote count information, lenders will frequently make sub-optimal voting decisions instead of bargaining for an appropriately structured amendment with a risk profile they can support.
Conventionally, consenting signature pages to amendment requests are executed manually by the individual lenders and then delivered to the borrower (utilizing bank agent's counsel) via fax, email of a scanned copy, hand-delivery, or overnight courier. This is an operationally inefficient and time-consuming method of delivery. For example, conventionally, lenders who may hold up to 50 sub-funds may typically have to execute up to 50 sets of unique signature pages—one set for each sub-fund. This creates administrative problems for lenders and is very time-consuming.
Bank loan investors often receive Material Non-Public Information (MNPI) from the borrowers to assist them in better evaluating the risks of the loans they are granting. However, anyone in possession of MNPI may be in violation of US securities laws if they also trade in the stocks or other public securities of those same companies while in possession of such information. As a result, institutional lenders who manage a collection of stock portfolios, bond portfolios and bank loan portfolios have to carefully manage their handling of MNPI to avoid any insider trading allegations. Bank loan amendments, including potentially the knowledge that an amendment is proposed, pose a series of risks associated with the dissemination of MNPI which could cause problems unless handled with appropriate safe-guards.
The receipt of amendment consent fees are generally unscheduled payments. The accountants and back-office personnel who track cash receipts typically do not know the timing nor correct amount of consent fees to expect and thus cannot tie the consent fee receipts unless notified. Because they do not have checks and balances in place to detect errors in the amount of consent fee received, they are inclined to simply accept the amount posted. Such errors may go undetected, potentially costing institutional lenders significant incremental fees, and at the very least require significant additional in-house and outside accounting professionals resource due to this absence of systems that provide the appropriate access to information.